Striking the right balance between conformance and performance

(Last part)

Enterprise Governance has emerged as a new concept which embraces the dual role of the board in fulfilling its fiduciary obligations while meeting stakeholder expectations. In this context, the IFAC/CIMA Report borrows a definition of Enterprise Governance from ‘Information Systems Audit and Control Foundation, 2001’ which reads as follows: ‘The set of responsibilities and practices exercised by the board and executive management with the goal of providing strategic direction, ensuring that objectives are achieved, ascertaining that risks are managed appropriately and verifying that the organisation’s resources are used responsibly.’

As pointed out earlier this definition ‘reflects the dual role of the board in both monitoring and strategy and acknowledges the inherent short and long term tensions between governance and value creation’. In addition it ‘emphasises the role of the executive management team’ and ‘covers the internal workings of the organisation, as well as the outward facing aspects’.

While taking a holistic view of enterprise accountability, it stands out that there is both a historic view (the conformance dimension) and a forward looking view (the performance dimension). ‘It makes it clear that good corporate governance is only part of the story – strategy is also important.’ This dichotomy is brought out clearly in the IFAC/CIMA Report in the form of a pictorial illustration.

One established practice in many organisations is the use of the Balanced Scorecard (BSC), developed by Kaplan and Norton."

As opposed to conformance which, in many instances, is considered to be the corporate governance process per se, Performance is described as the Business Governance Process. Conformance deals with Accountability and Assurance, while Performance primarily tackles Value Creation and Resource Utilisation.

Leaving aside the Conformance dimension, which by now is now quite familiar, it is interesting to explore the less charted territory of how the board strategically steers the enterprise and monitors its implementation.

The strategy oversight gap

The importance of strategy in driving performance has often been underestimated, and besides the perhaps annual getaway session, little attention is given to the realisation of vision and strategy and even less to the relevance of the strategy in a fast changing environment. Partly to be blamed is an over reliance on the finance function which drives the budgeting and performance reporting processes. As pointed out in a thought leadership report by ACCA and KPMG (Planning, Budgeting and Forecasting (PBF), An Eye on the Future), there is often a dichotomy between the PBF process, which is typically a short term one and the strategy process which has a longer term horizon. This results in misalignment with operational realities and strategic goals and in performance measures favouring short-termism instead of long term value drivers.

Furthermore, with each process working separately, there is a lack of sense of responsibility and accountability with dire consequences on decision making. The reliance on historical performance data rather than on rolling forecasts also lead to inappropriate decisions made in the wrong context.

The governance implication is a strategy oversight gap, the board being ill-equipped in terms of structure, tools and reporting mechanisms to allow it to effectively steer the strategy of the enterprise and take timely decisions to create long term value. This contrasts significantly, for instance, with the Audit Committee, which has now become a standard structure in most companies and, as the case studies covered in the IFAC/CIMA Report have demonstrated, provides effective board oversight as regards financial reporting. Needless to point that the spate of corporate failures, if ever needed, justifies the critical importance of such conformance mechanisms.

There are, however, many other case studies which bring home the lack of such oversight mechanisms for the performance or business dimension, one of them being the Royal Commission which investigated the HIH Insurance Group collapse in Australia. The Commission pointed out that “at board level, there was little, if any, analysis of the future strategy of the company. Indeed, the company’s strategy was not documented and... a member of the board would have had difficulty identifying any grand design. If the HIH board discussed strategy at all, it was in the context of an annual budget meeting. But budget sessions are generally about numbers, and there is no indication that the board seriously grasped the opportunity to analyse the direction in which the company was heading.” Strategy was the major cause of failure in this particular case, as in many others highlighted in the report.

Prone to ‘strategic drift’

One of the outcomes of such a situation is that many enterprises become prone to ‘strategic drift’ or ‘relative continuity’ where small incremental changes are made in reaction to changes in the business environment. A more serious outcome is when in aggressive expansion or distressful situations, the executive management team embarks on and gets fully absorbed in transformative change without fully updating the board, particularly the non-executive directors, on the new directions and the risks involved. With the lack of objectivity and transparency, the board is unable to grasp the strategic position of the enterprise at any point in time and thus constructively participate in strategic choice. Yet, as recognised in most Codes, the board is fully accountable for setting strategic directions for the organisation and, as pointed out in the HIH Case, ‘it is the board’s responsibility to understand, test and endorse the company’s strategy. In monitoring performance, the board needs to measure management proposals by reference to the endorsed strategy, with any deviation in practice being challenged and explained.’

There is therefore the need to have in place the appropriate mechanisms that will allow the board to fulfil its performance obligations. One established practice in many organisations is the use of the Balanced Scorecard (BSC), developed by Kaplan and Norton. While in some cases the BSC helps to give a coherent view of the business model and its business drivers, in most cases however it merely focuses on non-financial indicators and fails to address strategic issues, particularly at times of rapid change.

A more appropriate tool, developed by CIMA, is the Strategic Scorecard, which helps the board ensure that all the aspects of the strategic process have been completed thoroughly. As illustrated below, it helps the board to identify the key decision points and then the timing of strategic options, milestones in strategic implementation together with the identification and mitigation of strategic risks. Besides its utility in giving assurance to the board on strategic matters, it also provides a disciplined framework for management to continuously update the information and have a constant focus on strategy. There is a greater level of engagement with management which can only enrich the quality of board’s contribution to the strategic process and ultimately lead to better governance and performance.

One further recommendation in the report is that the board should set up a strategy committee. This is unfortunately not a common practice in most jurisdictions. One exception is France, where a good proportion of the CAC companies have done so. A recent report by EY however showed that only 5% of S&P companies had a strategy company, compared to more than 30% for Executive or Finance committees and around 11% for compliance or risk committees.

Frequent review of strategy, implying even a twice yearly getaway sessions, is nonetheless considered vital if enterprises are to keep pace with rapid change and assess management performance in a more valid way. Indeed, some of the dangers of performance management systems are the perverse and unintended consequences which result from rewarding the wrong attitudes and behaviours, or from failures to recognise that the goal posts are perpetually moving.

Changing the game in corporate governance

Sluggish growth rates in most countries are perhaps an indication that firms are not doing their level best to optimise their performances. Research is probably needed to show whether or not there has been too much focus on conformance and not enough on performance. There is however a strong temptation to pre-empt such analysis and to relax the regimes on regulatory compliance, as for instance in the United States, in a bid to boost the economy to new levels. This simplistic approach seems to be working, but, fresh as it may be in peoples’ minds, it is in complete disregard of the systemic risks that deregulation can bring about, propelled by unfettered greed and the reckless behaviour of rogue individuals and companies. Besides the economic impact, there are social and environmental factors which have now become embedded in the new governance frameworks and which very much constitute non-negotiable contracts for firms licenced to operate.

A less alluring, but perhaps more sustainable approach is for firms to give more serious attention to performance. Embracing Enterprise Governance, with a judicious balance between conformance and performance, may help organisations to make optimum use of their resources in order to achieve better stakeholder outcomes. This balancing exercise is the prerogative of the board, but no doubt requires some nudging in the right direction, and may require some changes in existing guidelines. This will benefit not only private sector organisations, but equally large public sector entities.

It is worth noting that international organisations insist on the use of monitoring and evaluation tools such as the logframes (short for logical frameworks) to ensure alignment between results, outcomes and the overarching goals of the programmes or projects which they are funding. These are similar to Enterprise Project Governance methodology and are in essence no different from the Enterprise Governance Framework being proposed here, all with the stated aim of bridging the gap between strategy design and delivery. At the end of the day, the convergence in governance and management design in public and private organisations is more than ever called for, in order to develop a common body of knowledge which can inspire and guide those charged with governance, irrespective of the sectors they serve.

Deva Armoogum, formerly KPMG partner, chairman of the Mauritius Institute of Directors and member of the National Committee on Corporate Governance, presently leads a boutique consultancy, EGSP Solutions.